Casey's General Stores, Inc. (CASY) Earnings Call Transcript & Summary

[Audio Gap] specialty retail as well as convenience stores at Raymond James. Today, I'm pleased to host a fireside chat with Darren Rebelez, CEO of Casey's General Stores. Darren, first, thank you for the time and the opportunity to host this discussion.

Thanks, Bobby. Good morning, and thanks for having me today.

Absolutely. So maybe to get us started, let's dive right in. Can you maybe talk about 1 or 2 of the key growth drivers or initiatives Casey's is really excited about for calendar year 2022?

Yes, Bobby. When we think about our growth for this coming year, it's really focused on 3 different areas of the business. First and foremost, we have this great chain of 2,400 existing stores. So we're always focusing on making those stores working hard -- work harder for us. And so there's a number of initiatives in our merchandising area really focused on private brand expansion. We've had a great reception of our private label business so far, and we'll continue to accelerate that. And within our prepared foods business. As you know, we've got a very large prepared foods business. And we're seeing good momentum there. We're going to continue to expand that. The second piece of that growth we'll focus on is on our rewards and our digital platform. And in fact, this month is our 2-year anniversary of Casey's Rewards. So we've had a great reception from our guests and that program is working hard. So we'll continue to focus on that. And then lastly, and certainly not least, is our store growth. And we've done a number of acquisitions this year, but we'll continue to accelerate our store growth because when we have that store working hard for us and the rewards platform really humming along, then the next step for us is just continue to do more of that. And we're going to continue to accelerate our store growth. So we're excited about all 3 of those levers for growth this year.

Absolutely. Maybe let's start with -- we'll dive into kind of each individual one here throughout the conversation. But I guess, maybe let's start with the store growth aspect. M&A has become an increasingly important part of the store growth. So maybe, first, how do you see the M&A environment playing out here in calendar year 2022? And has activity picked up versus the prior years given some of the cost pressures that are faced in the industry?

Yes. When we look at store growth, we look at it from 2 different perspectives. One is certainly M&A, and there's a lot of opportunity out there for that. But we also like to keep that ability to grow our store base organically, because sometimes, the right opportunities don't always present themselves from an M&A perspective. So we always want to have that capability to continue ratable store growth organically if those M&A opportunities aren't available. Now that being said, the current environment has been pretty favorable for us. Of course, we've announced 3 larger acquisitions this past fiscal year for us. But there's also a number of smaller tuck-in acquisitions that we've done that don't necessarily -- more in the press release, but they're still very good for us, and we continue to see a good environment for that. As you mentioned, cost pressures are rising for everybody, compliance pressures are rising, EMV costs are going up. So there's a number of things that make it more and more difficult for smaller operators to absorb. And that really improves our benefit and gives us the opportunity to purchase those at an attractive multiple.

Okay. And you mentioned some of the more larger ones you recently announced. When you think out not necessarily just calendar year 2022 but maybe even 18 months out, how do you and the team think about capacities? Do you have the capacity for another larger-scale one if they come about? Admittedly, the large acquisitions, timing is not necessarily up to you guys, it's when they're available. But do you have capacity if there was one that you found attractive? Or do you look at 2022 as more of a year of tuck-ins and integrate the 3 previous ones you previously mentioned?

Yes. We look at both the smaller tuck-ins as well as larger opportunities. And like you said, Bobby, those larger opportunities just aren't always available. So we have to be opportunistic when those things arise. Our integration team has done a fantastic job absorbing these different acquisitions. And so if I looked at them in order, there is the Buchanan Energy transaction that took place first and then the Circle K and then most recently in the pilot. With that Buchanan Energy one, we are well on our way on the integration process. They had a distribution center that we've unwound. Their back office is largely unwound at this point. A little over half of the stores we intended to remodel are already done and complete. So that work will start to subside. And then that would give us capacity to absorb another large one if that presented itself. But we also like those small ones. The small ones are plentiful, and we can tend to buy them at a more attractive multiple. They're easier to integrate. They have less integration risk. And we usually add more value to those as well.

All right. And that's a great pivot point. Maybe one last here on M&A, and then we'll move over to inside the store and some of the good things going on there. But what are some of the typical synergies Casey's looks to bring to the acquisition? And every acquisition admittedly different, but what's kind of a time frame to typically realize full synergies that you and the team would be targeting on different size acquisitions?

Yes. There's a few areas of synergy for us and it really starts with our prepared foods business. When you look at the vast majority of the businesses we buy, they really don't have any prepared foods business to speak of. And that's really our towering strength in this industry. And so when we layer that on, it's highly incremental at a very high margin rate. So that's really the first synergy. Certainly, we bring scale and sophistication. So from a procurement standpoint and a process standpoint, we bring those synergies to benefit. And then we have our rewards platform that we bring as well as our self-distribution. And that's something that most others don't have. And that definitely allows us to deliver those products far more efficiently. So those are the real big synergy areas.

Absolutely. All right. So maybe let's shift over to inside the store and we'll kind of -- we'll go first into kind of maybe the more GM, general merchandise area. And then we'll talk about prepared food and the dispensed beverage business as well. But you highlighted in kind of the opening remarks some good work with the private label initiative. So maybe what are some of the other key initiatives and drivers the team is focused on? And then let's maybe dive into the private label one a little bit more and talk about how that's progressing.

Yes. The private label has really been a great benefit for us. Something that we have truly come to appreciate is just how strong the Casey's brand is and how much it resonates with our guests. And so when we put our name on a product, it really resonates with people. And we've seen a great reception from our guests on our private brand products. And we ended the second quarter at about 4.3% private brand penetration. And with the goal of 5%, we're well on track to achieve 5% by the end of this fiscal year. And so we'll continue to broaden the assortment there. We most recently reformatted all of our stores or remerchandised all of our stores, broadened and deepened the assortment across most categories. And that's really resonating with our guests as well. And then we'll continue. We still have some more work on the merchandising side inside the store, specifically around our transaction counters and the cash wrap and really bringing that area to line. That's an initiative that you'll see in this calendar year.

Okay. And as you -- you mentioned kind of grows the strength of the Casey's brand. So as you've introduced certain private label products, are you finding new opportunities and maybe a subset of products that you didn't necessarily, when you first started this initiative, think could be something Casey's could do private label on?

Yes. We really look at it now and say that there's probably no categories that are totally off limits, private brand potential. Maybe tobacco would be one we would set aside. Outside of that, we think we can play in the private brand space and virtually any category. But some of the wins we've had early on, I'll take ice cream as an example. We started off with pints because we thought pints were a great way to go. But it became so popular with our guests, we expanded into half gallons. Within the chip category, we were more single-serve. That's resonated so well. We've gone into take home sizes and broadened the flavor profiles that we're engaging. Packaged bakery is another one very similarly. So we're seeing that as we go into categories, people like the products. And so we're just expanding that assortment even more.

Okay. And then maybe building off that, is the right way -- you mentioned a 5% target, but it seems like with that -- and you're pretty close to it with the success we're seeing in some of the categories. That can almost be maybe a moving target and there could be some opportunities to even be higher than 5% on a longer-term basis. Is that the right way to maybe think about that side of the business?

Yes, absolutely. We certainly think that 10% is achievable over time and then we'll have to see from there. But yes. 5% was just our fiscal year target for this year. And like I said, we're well on our way to achieving that.

Okay. And then I guess lastly on it, understanding all products across the store different. But is there an average number that investors could think about as the difference between a brand and a private label for your business of the gross margin benefit when you do shift into private label?

Yes. It's -- well, let me take a step back for a minute. When we look at introducing any private label product into our assortment, it's easy to meet 3 hurdles. The first is the quality has to be as good or better than the national brands. We have to be able to get a retail price to the guest lower than the national brand. We have to have a higher penny profit for us than we'd achieve with a national brand. So we have a fairly high bar to set just to get into the assortment. Now that being said, like you mentioned, all categories are different. But we'll see anywhere from a couple of hundred basis points improvement on margin all the way to 1,000 basis point improvement on margin. It really just depends on that category.

Very good. That's very helpful. Maybe to move over to the other side of the inside of the store business, prepared food and dispensed beverage. One of the areas, Darren, you highlighted, I think, at the original Investor Day, when we all met you when you joined the company, was an opportunity, over a couple of years, to refresh the prepared food menu and maybe to bring some new innovation there and to build off some of the very strong success Casey's has had in their pizza business and the brand value that comes with that. So maybe just to get a start, talk a little bit talk about where we are in that journey, how you do view the current offering there in prepared food and dispensed beverage. And we can kind of dive into a couple of different topics there.

Yes, sure. Certainly, the prepared food business is kind of the family jewels of the Casey's business. And it has done very well over a long period of time. But there are certainly areas that we can always be better at. And -- but that takes time. There's -- I think I shared with everybody on the Investor Day that it really takes about 18 months to really develop a properly prepared product development pipeline and see everything from ideation to commercialization. And so we're certainly beyond that now. And so we're starting to see the fruits of some of that labor. Really, where we've probably had our biggest innovation in the last 18 months or so is in our breakfast category. Now with COVID, the breakfast daypart overall has been the one most impacted by shutdowns and changes in community traffic. And so we want to focus on getting that back. So we've made investments in our coffee platform. We went to a bean to cup coffee platform, significantly improved the quality of the coffee, and we're seeing good results there. And then we took a look at the breakfast products. And it's really a combination of innovation and optimization. So in some cases, we had some existing products that we really didn't think met the quality hurdle that we were looking for. So our team has renovated those. And at the same time, added a new product, leaning into our capabilities around fresh-made dough in stores. And so our culinary team developed a signature handheld item, leveraging that dough. It's a really delicious, really delectable, very car-friendly, very portable item that has really resonated well with our guests. So there's a little bit of innovation, a little bit of optimization. And we're seeing kind of low to mid-teens improvements in our breakfast daypart ever since that launch in the second quarter.

Okay. And Darren, you mentioned the breakfast business, obviously, with COVID and traffic has been one of the areas hit. So maybe just for to level set investors, when you look at the mix of your business inside the store, breakfast, lunch, dinner, pre-COVID versus now, which areas are still kind of below that prior mix? And if there is a corresponding margin impact for us to keep in mind as we think about continuing to model a slow recovery in trends?

Yes. During the height of COVID -- well, let me back up. Before COVID, the mix was about 1/3, 1/3, 1/3. It's really evenly distributed throughout the day. And what we saw in the height of COVID was that morning daypart took a disproportionate hit in that mix and things shifted to a little bit later into the day. What we've seen more recently as commuting traffic has started to come back, we've seen that start to more normalize. And then with our new breakfast lineup, it really has resonated well. So we've seen a really strong recovery in that daypart.

Okay. Good. And then maybe to pivot, we'll talk a little -- switch over maybe more high level of the industry. I mean a couple of hot topics from investors from just a c-store perspective in general is -- first one is we get a lot of questions about is wage growth. So maybe can you talk a little bit about what the industry is seeing in terms of wage growth? And what are some of the steps Casey's is taking to handle that -- those trends and maybe to minimize the financial impact as best you can?

Yes. Certainly, with the labor shortage situation being what it is in the U.S. right now, we're absolutely seeing wage inflation in the second quarter. We had that right around 14% over the prior year. There's a little bit of noise in those numbers based on what we're cycling and COVID incentives from prior years being turned on, turned off at different points. But generally speaking, about 14% versus prior year. And that's very consistent with what we're seeing in the industry overall and from retail and hospitality in general. So that being said, we really believe that there is an inextricable link between OpEx pressure and fuel margin that's happening in our industry. Our fuel margins have been better than we've ever seen. Some of that's from self-help clearly. But a lot of that is just from the environment right now. And when you look at a lot of smaller operators, they don't have a lot of levers to pull like we do. And so that lever they do have tends to be fuel pricing, and that shows up on the price line. And that's helped to inflate margins to help compensate for that OpEx pressure.

Okay. And then you guys have done some work on optimizing hours and different things like that. Do you -- when you kind of -- more a longer-term question, but do you see further opportunities to rework things in the stores from a labor optimization standpoint or automatic checkout standpoint or self-checkout standpoint or different things like that, that could help kind of fight this trend if it's more of a longer trend we're in of wage pressure?

Yes. I'd say a couple of things. First, like you mentioned, we have done a lot around labor. And we had a time motion study, launched a new labor management system. And so if you looked at our most recent quarter versus pre-COVID 2019 on a 2-year basis, we were down 4.5% in labor hours used in our stores. But our sales were up almost 10% versus 2 years ago. So really getting great leverage on the existing labor. We still think there's opportunity within our kitchens to optimize those from a layout and process standpoint, be more efficient there. We have a team working on that now. And we've also talked more broadly about digitizing our entire business. So really having our IT team, our digital team, look at how we can employ technology to be more efficient really throughout the entire company, but certainly in the stores where most of the OpEx lies.

Okay. And first, when we kind of started this fiscal year for you, you guys reported a few quarters. When you look in OpEx, is labor really the one area that is pressuring and coming in maybe a little bit above what we would have forecasted to start the fiscal year? Is there other pressures inside the OpEx line as well?

Yes. Generally speaking, OpEx has come in about where we thought it would. I think you highlighted labor being in line and the wage growth. That certainly wasn't something that we had modeled to that extent. The other thing was credit card fees. Nobody anticipated retail price of fuel being $1 a gallon higher than the prior year. So that's been -- that's put additional pressure on OpEx.

And then maybe to level set us, investors and stuff, I mean, typical wage inflation before we've gone to this round in the industry is low single digits. And that's the -- where we to think about the magnitude of how big 14% is versus typical, is low single digits fair probably?

Yes. That is fair. Correct.

All right. And then I guess, lastly, on the wage side of things before we go to some other areas of kind of the industry. You guys have some long-term targets out there for EBITDA growth and things like that, and understanding near term with trends, it can move around a lot. But what's -- when you look at the long-term earnings algorithm for Casey's, what's the level of core OpEx that you and the team would feel comfortable with to be within those parameters to hit your long-term targets?

Yes. On our Investor Day, we shared with everybody that part of that algorithm was to keep our OpEx growth lower than our EBITDA growth. And certainly, in years like this year, when we have multiple acquisitions and cycling weird things with COVID, that makes that a little lumpy. But over the long term or medium term to long term, we absolutely are confident and we keep that OpEx at a lower rate than our EBITDA growth.

Okay. And maybe switching over to fuel margins because I do -- I agree with you also. They have a very strong direct link with what's going on here in the wage growth side of things. And one of the things investors have been pleased to see, and it's been interesting despite rising oil in calendar year '21, fuel margins remain very, very strong. So maybe can we unpack a little bit of what you think that recent strength is? We talked a little bit about OpEx, but also some of the initiatives Casey's has been working on. And we'll dive into some more questions on this subject as well.

Yes. Over the last couple years, we've really put a lot of effort around just being better at executing our fuel business overall. And so that's happened in a couple of different areas in pricing. We do centralized pricing now where it used to be decentralized out of the field. Today, we have a team of people that -- this is all they do every day. They have complete visibility to price surveys, complete visibility to commodity market, to supply situations. So they really have a holistic view of all the inputs that they need to make a great pricing decision. I think we've benefited from that. On the fuel procurement side, we've got about 75% of our business under contract now. So we're far more ratable. And we're always in a position where we are favorable to the market from a procurement standpoint. A couple of years ago, that was only 4%. So we're certainly far more sophisticated on that side of it. And more recently, we've implemented some new technology that streamline the accounting process on the back end but also help streamline the dispatching process so we can make sure that we're sending the right charts to the right terminals to where we get the most favorable cost. But that foundational technology work really sets us up for more sophisticated procurement, be it shipping product from a refinery gate up a pipeline into terminals and that sort of thing. So we're still on our evolution, but we've made a lot of progress so far.

Okay. And when you think about it, you guys have a very large store base. More rural, small town focused, of course, but there is even subsets of small towns that you operate in. Would you see any material difference in fuel margins when you're in your 5,000 or 10,000 population town versus a 50,000 population town? Is there any noticeable difference there in how you can drive fuel margins?

There's really not a big material difference. There is a bit of a difference. In some of our most recent data, I would call it about 50 basis points. So it's not a big gap between them but certainly is impacted so.

Okay. And then one of the questions we get a lot is what -- there's cost pressure space in the industry. We've talked about it, credit cards, the chip investments for the pumps, wage growth, et cetera. If investors trying to think, at least my view is a lot of those pressures are going to continue at least here in 2022. So if there was something that was going to revert these fuel margins back to kind of pre-COVID or even just down, what would drive it? If the cost pressures are continuing, it seems like there's a great argument for these higher margins to be more sticky and sustainable.

Yes. I'm not so sure, Bobby, that these margins are going anywhere anytime soon. I think there's a few different dynamics in play. Obviously, there's cost pressure, but there's also of volume pressure as vehicles become more efficient. And as the work-from-home environment reduces commuting traffic, that will certainly put some upward support for margins over the medium term. So I would expect them to stay for a while.

Okay. And another industry topic we get a lot of questions on is electric vehicles. Those have become bigger and bigger pieces of the news here. And while less maybe likely of a concern given your more rural footprint, maybe just talk a little bit about how Casey's has positioned itself over the medium and longer term as EVs become more relevant.

Yes. I think we're really well positioned to address the evolution of EVs. First, when we think about it, first and foremost is our real estate. Our stores are already positioned where the commuting traffic is going. And so whether the vehicle is being fueled by gasoline or electricity or anything else, the cars are still going to travel the same commuting routes. And so we're already positioned really well for that. The second thing that I think really sets us up well is our in-store experience. So I'll start by saying about 75% of our business is -- or our transactions are nonfuel related. And that's because we have a very robust store offer led with our prepared foods. So when you think about the electrical vehicle charging experience versus a gasoline experience, gasoline takes about 5 minutes, you're in, you're out. With a rapid charger for electric vehicles, it takes about 30 minutes. Well, there's a dwell time issue there that we have to satisfy. Well, with us, with having a strong prepared foods business, we have an offer that people can come in, breakfast, lunch or dinner, sit down in the store, enjoy a meal while they're charging and then move on their way. So we're already really well positioned from that perspective as well.

Good. We have about 5 minutes left, so maybe 2 final topics. You touched on it briefly when we first started, the loyalty program, and that's been a big push over the last couple of years here, Casey. So maybe can you update us on where Casey's is in that journey of loyalty and what some of the trends you're seeing from customers as you've developed that program better?

Yes. Like I mentioned earlier, January is our second anniversary of rewards. And happy to say we're about 4.2 million rewards members enrolled as of the end of second quarter. So that has really exceeded our expectations from an enrollment standpoint. And what we're finding with those guests is a couple of things. The relationship we have with them is much stickier. Our rewards members visit a Casey's store 15% more frequently than a non-rewards member, And they spend 6% more per transaction than a non-rewards member. So those are really great facts. So our push right now is from a couple of fronts. One is to continue to enroll more people in the rewards program. And the second piece is further optimizing our marketing messaging to those guests and shifting that more towards personalization. By the end of this fiscal year, we should have 75% of our messaging to our rewards members being personalized based on their purchasing habits and tailor -- making offers to satisfy their needs.

Okay. That was actually the second part of my question. Any big changes or pushes in loyalty for this year? And it seems like more personalization and getting that initiative done. Anything else you think is worth highlighting about what could be coming on the loyalty side here in calendar year 2022?

I mean we're always working on optimizing that platform. But really, the big push right now is on expanding the enrollment base and personalizing the engagement.

Absolutely. And no fireside chat is complete without the standard capital allocation discussion. So we don't want to leave that out in the last couple of minutes. But maybe can we talk a little bit about how you and the team think about capital allocation? And with the pressures facing the industry, if you think on the small operators, is M&A going to continue to become a bigger framework? Because the small operators just face ongoing pressures that the larger operators are able to offset better.

Well, certainly, our focus for our cash is to deploy it against growth. And I think you've seen that over the last several years that we've accelerated our store growth. So we're focused on putting that cash to work on growing the business, whether that's via organic or M&A store growth or in-store initiatives that help the entire chain work harder for us. We're certainly very proud of our dividend. We have a multi-decade track record of increasing that dividend on an annual basis, and we don't see any change in that. And then lastly, we have a share repurchase authorization of $300 million. We have not used that most recently. But it's out there if the situation arises. But really, our focus is on deploying the significant cash that we generate in this business towards growing the business itself.

Absolutely. And one of the more unique things you mentioned kind of ties into capital allocation. You guys are self-distributed with your 3 DC centers and recently just opened up a new one, the third one. What kind of runway does that give for potential store growth versus where you're at today? And when another required one would have to come, how much room do we have for new stores?

It really kind of depends on the geography where our store growth takes place that would drive maybe a fourth distribution center decision. Within our existing distribution footprint, we can add about 1,000 stores and still be able to support them if we were to spread that evenly throughout the footprint.

Absolutely. So ample room there. Okay. Well, we have about a minute left here, so I'll turn it back over to you for any closing remarks. But I've really enjoyed the discussion. So I want to thank you again for the time and the opportunity here to host it.

Well, thanks, Bobby. I appreciate the opportunity to speak with everybody. And I would just say we feel really good about our spot right now in the industry. It's a consolidating industry. I think we've proven our ability to be a consolidator in that industry. We're a differentiated brand with our really strong prepared foods business. We're the third largest convenience store chain, but we're the fifth largest pizza chain in the U.S. and really getting more sophisticated in that area. And then we have this great technology platform with our rewards business that is really taking off. And so as you look at the landscape, we're well positioned to grow in the future. And we're excited about what the future holds for us.

Absolutely. Well, thank you, and thank you, everybody, for joining us, and have a great rest of the week.

Thanks, Bobby.